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New insurance product: emotional insurance

In a nutshell

Behavioural finance is now moving beyond helping advisors and investors understand and overcome emotional traits that impact investment decisions.

Behavioural finance is now being productized - products and solutions are being created that either help professional investors tap into irrational excesses to make money or help them avoid their own behavioural traits that detract from delivering better fund performance

For individual investors, there's a new solution in the works: an emotional insurance solution, which attempts to do what an advisor is trained to deliver - help investors understand their emotional impulses better and keep them from falling prey to impulses that impact good investment decisions.

MasterMind - a joint initiative between Sundaram Mutual and Wealth Forum, aims to help advisors and distributors understand the world of behavioural finance, understand your clients' minds better, and on this basis, become more effective and successful advisors.

MasterMind has been consistently showcasing various facets of the exciting world of behavioural finance and how you as advisors can use these insights to understand your clients' minds better, relate better to how they think and feel, communicate better and thus become far more effective as your clients' advisors.

Today, we are going to discuss a whole new dimension of behavioural finance: the use of behavioural finance feedback tools in the world of money management. Just as there is a growing interest in robo-advisors that seek to replace human intervention in financial advice, there is now growing interest in developing behavioural finance feedback tools that can guide investors as well as fund managers to steer clear of behavioural tendencies that can adversely impact financial decisions. There are also feedback tools that seek to detect behavioural anomalies in the market place, with a view to exploit them and make money out of irrational behaviour.

Making money out of irrational behaviour

Fund managers are paid to exercise independent judgement and come to their own conclusions on stocks. But, there is also significant alpha potential in identifying mispriced stocks, where her mentality has taken a stock's price to an extreme. Contra investing includes this element of stock picking.

Globally, specialist research firms have been set up that sift through huge masses of data, analyse them with complex algorithms and produce actionable insights on market sentiment, which is very useful to fund managers who seek to exploit irrational extremes in market sentiment.

Specialist research firms like Market Psych, as the name suggests are geared to track market psychology across asset classes covering over 30 countries, 20 currencies, leading global commodities and key US sectors. The firm claims to have the world's most comprehensive sentiment data that it compiles in association with Thomson Reuters. It then analyses this data - which it sources from news, social media and a host of diverse sources and presents its subscribers comprehensive dashboards that provide overviews of sentiment data across entire asset classes. This data shows patterns of abnormal behaviour or build up of any extreme sentiment in asset classes in the geographies that it covers, which serve as useful data points for money managers to detect pricing anomalies that they may wish to exploit to make money. This is neither fundamental research nor technical analysis. This is a new field of study called sentiment analysis, which recognizes that behavioural anomalies can distort market prices of assets, and that such distortions, if picked up and analysed in a scientific manner, give rise to money making opportunities to enterprising money managers.

Helping fund managers iron out their own behavioural issues

Cabot Research is a US based behavioural finance specialist firm that helps professional equity fund managers enhance their performance by becoming more self-aware of their own behavioural traits. Some of these traits may be detrimental to fund performance while others may be key contributors to performance. What this firm does is to help fund managers build on their behavioural strengths and work on their behavioural weaknesses, to enable them to deliver consistently superior fund performance.

Helping investors iron out their behavioural issues

We've heard of life insurance policies, home insurance, car insurance and insurance for every asset we own. Welcome now to the age of a new insurance product: an emotional insurance solution. The behavioural and quantitative investment philosophy unit of a global bank is engaged in creating a comprehensive solution that allows individual investors to rein in emotional excesses that can impact their investment decisions. It starts with a sophisticated psychometric analysis that helps an investor discern emotional patterns that are likely to contribute to and detract from good quality investment decisions. It then goes on to help investors build their personal Investment Constitution, which will govern their investment decisions, rather than allowing emotions to do so.

This Investment Constitution in effect will seek to replace the role of an advisor in helping rein in emotional excesses that can lead investors towards irrational decisions. That said, only time will tell whether investors will meticulously follow their investment constitution when emotional excesses strike, or will they still prefer the trusted shoulder of their advisor to lean on when the going gets tough.

All content in MasterMind is created by Wealth Forum and should not be construed as an opinion of Sundaram Mutual Fund.

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